Microsoft-Yahoo: of bids, poison pills, and hostility

It's a flashback to AOL-Time Warner, and probably not worth the pain. Steve …

Microsoft has been sniffing around Yahoo for the last 18 months, but the twain could never quite agree on a fair deal in private. Mr. Softy decided to take the matter public.

Terry Semel may have triggered the offer on Thursday, when he announced his resignation from the Yahoo board. At the last published count, he had 25 million unexercised stock options on hand, giving him a serious say-so in this deal (more on that later). Of course, the declining share price must have helped too, as Microsoft slapped together an offer that's below the stock's 52-week high of $34.08 per share—and still gets to look generous. Before the offer, the average Wall Street analyst thought Yahoo was worth about $27 per share, standing on its own two feet.

Hostile proceedings

The announcement you saw on Friday morning wasn't a done deal, though. It's what you'd call a "hostile" takeover by definition, where the would-be buyer sends in a bid for every share on the market. Then, the company hopes to convince enough shareholders of the offer's virtues to gain a controlling stake in the target company. After that, it's a simple matter of calling a special shareholders' meeting to elect a new board, automatically win every seat, and then fold the whole operation into your own. Case closed.

But things don't always work out that way. And I don't think it will be smooth sailing this time. Jerry Yang and his crew have not shown any desire to be acquired, and for good reason. If Microsoft gets to have its way with Yahoo, this could be the biggest misuse of brand value and shareholder assets since Time Warner merged with AOL. The cultures are poles apart, there is too much overlap between the two operations—and Yahoo really doesn't need a big brother's help right now.

Buster, bluster or filibuster?

The Yahoo board has taken an appropriately thoughtful stance so far, promising to look the offer over and to evaluate all strategic options. "A review process like this is fluid, and it can take quite a bit of time," said the statement. And it's not just empty talk, either. The board has some anti-takeover tools in its arsenal.

There's a "poison pill" provision in play, which would allow the board to issue up to 10 million shares on new stock in case there's an acquisition offer on the table that they don't want to endorse, and each share can have nearly unlimited voting power. Furthermore, every director would be allowed to cash in all of their outstanding stock options immediately with an unsolicited offer on the table, and that's about 16 million potential new shares. Such a situation could get considerably more expensive for Microsoft.

Fan reaction

Judging from the share price action, neither Microsoft's shareholders nor Yahoo's like this offer very much. Microsoft stock dropped 6% on Friday, which actually lowered the value of a deal with 50% of the bid coming from a stock swap. And while Yahoo investors saw their shares worth 48% more by the end of the day, $28.38 is still less than the proposed $31 bid. That means investors are hoping for a better offer.

So can Microsoft step up its game any further? Well, the cash component of the current offer is a hefty $22.6 billion, and the Redmond Raiders only have $19.1 billion of cash equivalents on hand. That means taking on debt, which would be the first long-term borrowing since at least 1991. That's where my sources fade into the mists of time and electronic availability.

Where to, captain?

The bigger question is what the Yahoo board says, and how Microsoft responds to that. Given Yahoo's new direction and refreshed corporate structure, I would wager that an outright "yes" is out of the question. There is more value in a separate Yahoo that can set its own plans into motion than there is to a Microhoo conglomerate where Microsoft's goals take precedence. Hold out for a massive overpayment or none at all, is my opinion.

Microsoft might still do it, though. Steve Ballmer says that he
sees the online advertising market doubling to $80 billion in two
years, and he'd like a slice of that sweet, creamy pie. The less he
has to share with Google, the better. Yahoo's $7 billion in 2007
sales looks huge next to Microsoft's online division producing $1.5
billion—but it's less than half of Google's $15 billion revenue
take.

The business case for sweetening the offer looks compelling if you assume that the combined company will gain market share back from Google in the near future, and that he integration of the two companies is smooth as greased butter on Teflon. Ballmer might see it that way, but I think he'd be wrong on both counts. So if this deal happens, it'll be after dragging Yahoo shareholders and board members along, kicking and screaming. Microsoft will overpay for the company, and will end up weakening Yahoo in the process.

Pay more, get less. I'd be sorry for everyone involved to see it happen.